Download FRL 301 Final Exam: Incremental Cash Flows, Risk, and Capital Asset Pricing Model and more Exams Advanced Education in PDF only on Docsity!
FRL 301 Final Exam 100% Verified
Incremental Cash Flows are also known as... - ANSWER Relevant cash flows
Define "incremental cash flows". - ANSWER The difference between a firm's future cash flows with a project and those without the project.
What can be an incremental cash flow item? - ANSWER Incremental cash flows consist of all changes to the firm's future cash flow that are directly related to taking on a new project. Any costs that is not related to the project, aren't included in our evaluation of whether or not to take on the project.
What is the "stand-alone principle"? - ANSWER Basically since the project itself, if we take it, is like a smaller firm, we could just evaluate the cash flows of that project to the cost of getting the project done.
What the hell are sunk costs? - ANSWER Basically these are the costs that you paid for and there's not chance in a motherf#cking hell you can ever get it back. No f#cking refunds, so they're "sunked". Don't f#cking include them with incremental cost evaluation.
What the fck are opportunity costs? - ANSWER These are basically costs that like, you lose a chance to do something because you did something else. Like, you wanna fck this hooker, but you spent the money on a PlayStation instead.
What are the f#cking side effects of taking a project? List the f#cking positives first, dipsh#t. - ANSWER The positive side effect of this f#cking project is that it could help the cash flows of other products. For example, if the costs of a printer goes down, that doesn't really f#cking matter, because people still need their toner and sh#t so you'll still make a killing even after you printer model is dated. Get it f#cker? A##hole.
What are the side effects of taking a project? List the negatives this time you
wrist-cutting, pill-eating, bulimic piece of sht. - ANSWER There is the fcking erosion effect, where taking a project could hurt the other things you be selling, ya feel me dawg? Let's say you be selling some DVDs a few weeks after the movie comes out in theaters. think about it, why spend 40 dollars on a theater, when you could wait 2 more weeks for a DVD? Right? Yes.
What the f*ck is net working capital? - ANSWER Pretty much it's money that you got to be spending on the day-to-day business operations. Things be like the initial inventory and things like the accounts receivable to cover for credit sales. Yup. Just... just know what it is. You get it.
What are financing costs? - ANSWER Financing costs are what they sound like, f#cking sh#t that you finance. Don't put it in the evaluations, because we don't give a sh*t of what we put in, we only care of what the project makes on it's own terms.
What the f#ck is systematic risk? (and why did you get it wrong on the test? dumba##) - ANSWER They the risks that affect everything, or most of. So like if the economy goes to sh*t, then your stocks will die. Get it? You cannot control the economy. Alright.
What's another word for systematic risk? - ANSWER -market risks
-nondiversifiable risk
What the f*ck is unsystematic risk? - ANSWER They the risks that only affect like one asset or like only one single company or whatever. These can be controlled through diversification. Imagine an oil company, struck more oil. They'll get affected and maybe some others, but a sex toy company won't get affected by such news.
What are other words for unsystematic risk? - ANSWER Unique risks or like asset-specific risks
Why do we need risk? And what risk do we need? - ANSWER We need risk because because there is some reward to holding that risk. Why? Just accept and move on, that's why.
What does it mean when beta = 1 - ANSWER Systematic risk is the same as the market
What does it mean when beta < 1 (less than 1) - ANSWER Systematic risk is less than the market
What does it mean when beta >1 (more than 1) - ANSWER Systematic risk is more than the market
What is reward-to-risk ratio? - ANSWER Basically it is our risk premium divided by the asset's beta.
What the f*ck is risk premium? - ANSWER Risk premium is pretty much just the expected return minus the risk free rate. Yeah.
How do beta and the risk premium affect the reward-to-risk ratio? - ANSWER Since it's simple slope of a line, imagine the following:
The higher the risk premium, the slope is higher.
The lower the risk premium, the slope is lower.
The higher the beta, the slope is lower
The lower the beta, the slope is higher.
Just draw it out if you're stuck on the test homie.
What is CAPM? (The name?) - ANSWER Capital Asset Pricing Model
What is the CAPM actually? - ANSWER It is the equation of the SML that shows the
relationship between expected return and beta.
What are the 3 variables of CAPM? - ANSWER 1. Pure time value of money
- The reward for bearing systematic risk
- The amount of systematic risk
Describe "Pure time value of money" - ANSWER This is measured by the risk-free rate, and it is pretty much the reward for waiting for your money without any risks.
Describe "reward for bearing systematic risk" - ANSWER This is measured by the market risk premium (same as risk premium, but for the market), and it shows the reward the market gives you for holding onto an average amount of systematic risk, while waiting.
Describe "amount of systematic risk" - ANSWER This is measured by Beta, and it's just the amount of systematic risk you have in an asset or a portfolio, and it's relative to the average asset.
What is the security market line, and what does it have to do with CAPM? - ANSWER -It is also known as the market risk premium, and we use it to compare the pricing of portfolios in a market.
-According to CAPM, it is equal to the market risk premium.
SML - In terms of reward-to-risk ration equation? - ANSWER Since the SML is for the market, the Beta has to be 1. That's why the equation assumes 1, and that's just a pretty good thing to know.
What is an overpriced asset relative to the SML? - ANSWER An asset is overpriced if it's plotted above the SML, which then it needs to be lowered in value.
What is an underpriced asset relative to the SML? - ANSWER An asset is underpriced if it's plotted below the SML, which then it needs to be raised in value.
What are Flotation costs? - ANSWER - Costs from possible requirements of issuing new stocks and bonds, thus incurring costs.
- Arises from new projects that require issue, or float of new stocks and bonds.
How do you determine firm value? - ANSWER It's determined by cash flows to the firm and the risk of the assets. It's not affected by changes in capital structure.
What's the relationship between capital structure and the cost of capital (or WACC) - ANSWER - The capital structure with the lowest WACC shows the most maximized value of the firm.
- We could say a particular debt-equity ratio represents the optimal capital structure if it results in the lowest possible WACC.
What is leverage? - ANSWER The use of financial debt
What happens if there's a change in leverage? - ANSWER A small change in leverage results in a large change of profits
What the f#ck is M&M proposition I? - ANSWER The value of the firm is completely irrelevant from the way it is structured financially.
What the f#ck is M&M proposition II? - ANSWER The cost of equity depends on three things:
- The required rate of return
- The firm's cost of debt
- The firm's debt-equity ratio
What is business risk? - ANSWER This is the equity risk that comes with the nature of the firm's operating activities.
The greater a firm's business risk... - ANSWER ... the greater required return on the firm's assets overall, and the greater will be the firm's cost of equity.
What is financial risk? - ANSWER This is the equity risk that comes from the financial policy (capital structure) of a firm.
The firm's cost of equity rises when... - ANSWER the firm increases its use of financial leverage because the financial risk of equity increases while the business risk stays the same.
What is interest tax shield? - ANSWER Tax saving from interest expense
Basis of M&M Proposition I with taxes? - ANSWER The value of the firm increases as total debt increases because of the interest tax shield.
M&M I with taxes implies that... - ANSWER a firm's WACC decreases as the firm relies more heavily on debt financing
M&M II with taxes implies that... - ANSWER a firm's cost of equity, rises as the firm relies more heavily on debt financing
What are direct bankruptcy costs? - ANSWER - Legal and administrative costs
- Causes bondholders to incur additional losses
What are indirect bankruptcy costs? - ANSWER - Larger than direct costs, hard to estimate
- Stockholders want to avoid formal bankruptcy
- Bondholders want to keep assets intact to receive money
- Assets lose value as management spends time worrying
- Firm may lose sales, experience interrupted operations, and lose valuable employees
Exchange rate risk - ANSWER The risk related to having international operations in a world where relative currency values vary
Absolute Purchasing Power Parity - ANSWER - Price an item should be same in real terms
Requirements of Absolute Purchasing Power parity - ANSWER - transaction cost of 0
- No barriers to trade
- No difference in commodity between location
Relative Power Parity - ANSWER Provide information about what causes change in exchange rates. Rates depend on relative inflation
Interest rate parity - ANSWER Forward rate that prevents arbitrage opportunity
Uncovered Interest parity - ANSWER Condition stating that the expected exchange rate is equal to the difference in interest rates
International Fisher Effect - ANSWER Tells us that the real rate of return must be constant across countries. Otherwise investors move money to country with higher real rate of return.
